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The Obama administration has made it clear Fannie and Freddie will ultimately be wound down and replaced by private capital. The three proposals on the table, set forth in the administration’s report to Congress this past February, each propose a privatized system of housing finance with varying levels of government assistance. According to the report, the options include:
Government-insurance role limited to FHA, U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA) assistance for narrowly targeted groups of borrowers;
Assistance from the FHA, USDA and VA for narrowly targeted groups of borrowers and a guarantee mechanism to scale up in times of crisis; and
FHA, USDA and VA assistance for low- and moderate-income borrowers and catastrophic reinsurance behind significant private capital to be paid out only if the private guarantors’ shareholders have been entirely wiped out.
Clearly, this is a big change from the existing mortgage system supported by Fannie Mae and Freddie Mac. According to Laurie Goodman, senior managing director at Amherst Securities, however, a realistic timetable for the impact of government mortgage reform wouldn’t be until 2017 as she expects no new legislation to be passed until the second year of the next presidential term (i.e., 2014) at the earliest. So there should definitely be enough warning and transition time for these changes to take effect. Goodman also said she believes there is a slight chance that Fannie Mae and Freddie Mac will survive in their existing form if they are profitable by 2013.
Because the government currently funds such a large share of mortgages, it is difficult to envision a mortgage market without Fannie Mae or Freddie Mac. FHA will likely constitute a much smaller share of the mortgage market, returning to its original goals of helping underserved borrowers.
According to a bill recently introduced by members of the House Financial Services Committee, Fannie and Freddie likely will be replaced by 15 to 20 companies that would purchase mortgages and securitize them with an explicit government guarantee.
If this plan goes through, I expect that these companies would essentially take on the current role of Fannie and Freddie, buying QRMs and non-QRMs from originators and issuing mortgage-backed securities against them. I envision each company would be required to pay a fee to a government agency for guaranteeing the mortgages and that these fees would go into a fund to be used to pay any claims if mortgage-backed securities went into default. Having 15 to 20 companies would theoretically allow any of the companies to go bankrupt without any major disruptions to the mortgage market.
Ideally, the smaller companies would seamlessly replace the GSEs with minimal disruptions to the market. Given that they will need to build up their infrastructure and processes to purchase and securitize large volumes of mortgages, however, we can expect significant challenges with implementation.
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Mortgage originators should take steps now to adapt to the coming environment. In the next several years, the rules will continue to be rewritten for the mortgage industry, setting the groundwork for the next few decades. Those who actively participate and prepare themselves will likely be the leaders during the next phase.
Daniel Yeh is director of mortgage products at Scotsman
Guide Media. Reach him at (800) 297-6061 or email@example.com.
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